Question

The most important factor affecting the credibility of the auditor is that of independence.

What is your understanding of independence and also how can an auditors independence be compromised or threaten?

Notes:

You may give example/s to support your statements.

Minimum 700 words answer is required.

Avoid any type of plagiarism.

Mention your sources: websites, books, journals etc.

Answer 1

What is Auditor Independence?

Auditors are expected to provide an unbiased and professional opinion on the work that they audit. An auditor who lacks independence virtually renders their accompanying auditor report useless to those who rely on them.

Audit independence is important so that auditor's opinion can be impartial, unbiased, free from any undue influence or conflict of interest to override the professional judgement of the professional accounting.

Being able to xpress a totally unbiased opinion on the financial statements of an entity is what defines Auditor's Independence.

For example, consider yourself a potential investor in ABC Company. If you know that the auditor for ABC Company keeps a close, personal relationship with the CEO of the company, how much would you trust that the audited work is a fair representation of the company’s financial standing? How can you be certain that the auditor and CEO did not collude to issue a favorable audit report?

The fact is that auditors who lack independence compromise the integrity of financial markets and the reliability of information. Investors would not be willing to extend capital to companies, knowing that the audited information was performed by an auditor who is not independent. Furthermore, banks would not be willing to issue a loan for fear that the auditor might’ve provided a biased audit report.

Threats to Auditor Independence

The following are the five things that can potentially compromise the independence of auditors:

1. Self-Interest Threat

A self-interest threat exists if the auditor holds a direct or indirect financial interest in the company or depends on the client for a major fee that is outstanding.

Example

The audit team is preparing to conduct its 2020 audit for ABC Company. However, the audit team has not received its audit fees from ABC Company for its 2019 audit.

Issue

The audit team might be tempted to issue a favorable report so that the company is able to secure a loan to settle the fees outstanding for their 2019 audit.

2. Self-Review Threat

A self-review threat xists if the auditor is auditing his own work or work that is done by others in the same firm.

Example

The auditor prepares the financial statements for ABC Company while also serving as the auditor for ABC Company.

Issue

By having the auditor review his or her own work, the auditor cannot be expected to form an unbiased opinion on the financial statements.

3. Advocacy Threat

An advocacy threat exists if the auditor is involved in promoting the client, to the point where their objectivity is potentially compromised.

Example

The auditor is assisting in selling ABC Company while also serving as the auditor for the company.

Issue

The auditor may issue a favorable report to increase the sale price of ABC Company.

4. Familiarity Threat

A familiarity threat exists if the auditor is too personally close to or familiar with employees, officers, or directors of the client company.

Example

ABC Company has been audited by the same auditor for over 10 years and the auditor regularly plays golf with the CEO and CFO of ABC Company.

Issue

The auditor may have become too familiar with the client and, thus, lack objectivity in their work.

5. Intimidation Threat

An intimidation threat exists if the auditor is intimidated by management or its directors to the point that they are deterred from acting objectively.

Example

ABC Company is unhappy with the conclusion of the audit report and threatens to switch auditors next year. ABC Company is the biggest client of the auditor.

Issue

The auditor’s independence may be compromised, as ABC Company is their biggest client and they, quite naturally, do not want to lose such a client. Therefore, the auditor may issue a report that appeases ABC Company.